A Handy Port in a Storm: Systematic risk management in turbulent times | BetaShares

A Handy Port in a Storm: Systematic risk management in turbulent times

BY David Bassanese | 29 March 2016

The Australian share market – along with global equities – has experienced a relatively turbulent few months.  After having had one of the worst starts to the year on record, the S&P/ASX 200 Index has since mid-February enjoyed an impressive rebound.  In view of this market volatility, it has been a “baptism of fire” of sorts for our recently launched Managed Risk Australian Share Fund.  But as this note demonstrates, the Fund has come through this period with flying colours.

A Turbulent Time for Stocks

It’s fair to say the Australian stock market got off to a rocky start this year.  Having closed at 5344.5 points at the end of 2015, the S&P/ASX 200 index had by the market close on February 12 dropped by 9.9% to 4816.6 points.  Investors were naturally worried.

But, as the saying goes, it’s always darkest before the dawn. Thanks particularly to expectations that the US Federal Reserve would postpone further interest rate increases in light of global market volatility, the Australian market then rebounded nicely.  By March 14, the market had recovered to 5242.4 points, or 8.8% – to be down only 1.9% since the start of the year.

As seen in the chart below, recent pull backs in the market have tended to be associated with upsurges in market volatility – a general feature of markets which has been utilised within the risk management strategy used by the BetaShares suite of managed risk exchange traded products.


A Systematic Approach to Managing Risk

The BetaShares Managed Risk Australian Share Fund (managed fund) (ASX Code:AUST) was launched on 9 November 2015 – just in time to negotiate the treacherous market conditions of early 2016.  The Fund’s aim is to provide exposure to a broadly diversified portfolio of Australian shares, while reducing the volatility of returns and cushion downside risk.

How is this achieved? The Fund’s core market exposure is achieved by investing in a passively managed portfolio of large-cap Australian shares, according to their market capitalisation.  At the same time, the Fund primarily seeks to achieve its risk management objective by using a rules-based systematic strategy that actively aims to reduce* the Fund’s net-market exposure at times of higher market volatility.

As noted above, this strategy aims to exploit the general tendency of increases in market volatility to be associated with (and often anticipate) periods of market weakness.  The risk management rules used by the Fund are run in conjunction with Milliman, one of the largest institutional risk managers in the world.

As seen in the chart below, the Fund’s strategy looks to reduce net-market exposure as market weakness develops, but then re-establish market exposure as the market strengthens – so that the Fund then becomes well placed again to participate in sustained market recoveries.  By its nature, therefore, the Fund’s strategy will tend to reduce market exposure (with potential to outperform the market) in volatile periods of market weakness, though can also be expected to underperform where the market is in a recovery phase, as the presence of the risk management strategy should mean that the Fund will not be fully exposed to the share market.

Past performance is not an indicator of future performance. 
The systematic rules based approach to risk management used by AUST has the benefit of avoiding the psychological biases that may plague the efforts of some investors to manage risk over the cycle using their own discretionary judgements, or “gut feel”.  Indeed, the evidence suggest investors on average tend to be too slow to respond to market downturns and subsequently too slow to  respond to signs of a market upturn.

The Proof is in the Pudding

So how has the Fund performed?  As seen in the chart below, AUST has largely met its investment objectives so far. Since inception, the Fund has generally exhibited much less volatility: it has fallen by less than the market during periods of weakness, and rebounded by somewhat less during periods of market strength.  In fact, the average absolute daily percent change in the Fund since inception has been 0.45%, or half the 0.9% average daily change for the S&P/ASX 200 total return index.

Past performance is not an indicator of future performance. 

Note, moreover, that despite the fact the market has been largely range-bound since AUST’s inception (which is not normally the type of market environment suited to “risk-on/risk-off” strategies as employed by AUST), there has not been a significant trend of under performance by the Fund due to the dynamic nature of the risk management strategy employed.

Indeed, at the bottom of the market in mid-February, AUST was outperforming (since inception) by around 3%.  With the more recent market rebound, in which AUST has lagged, the market is now ahead by 2% since inception.  Should the market experience further weakness this year – as is possible if earnings drop further and/or as the United States lifts interest rates – there’s scope for AUST’s recent period of under performance to again be reversed.

Managing Global Equity Risk

Note along with the AUST, BetaShares also launched the BetaShares Managed Risk Global Share Fund (managed fund) (ASX Code: WRLD) in mid-December. The Fund aims to provide exposure to a broadly diversified portfolio of global shares, while – as with AUST – also utilising a systematic risk management strategy that actively aims to reduce the volatility of returns and cushion downside risk.

As seen in the chart below, WRLD has also helped protect investors from the worst of the global market downturn earlier this year, and is still ahead of the MSCI World Equity Index in terms of investment performance since its inception.

Past performance is not an indicator of future performance. 
*Note, to limit brokerage costs and capital gains implications, the Fund does not sell underlying securities to reduce market exposure when required. Instead the Fund sells or “shorts” highly liquid Australian share price index (“SPI”) futures.  As the value of this short position rises as the market falls (and vice-versa), this effectively acts to reduce or “hedge” the Fund’s overall net-market exposure. Both AUST and WRLD do not track a published benchmark. The performance of AUST and WRLD since inception is short term in nature, and should therefore be taken as illustrative only and not necessarily indicative of longer term fund performance.    

Leave a Reply